Question

Alpha and Beta are divisions within the same company. The managers of both divisions are evaluated based on their own division's return on investment (ROI). Assume the following information relative to the two divisions: 51,000 283,000 101,000 206,000 51,000 283,000 75,000 206,000 Alpha Division: Capacity in units Number of units now being sold to outside customers Selling price per unit to outside customers Variable costs per unit Fixed costs per unit (based on capacity) Beta Division: Number of units needed annually Purchase price now being paid to an outside supplier $ $ 104 $ 68 $ 42 $ 22 $ 61 $ 38 $ 47 34 $ 27 $ 11 $ 17 $ 9 23,000 58,000 10,200 97 $ 72,000 41 $ $ 61 *Before any purchase discount. Managers are free to decide if they will participate in any internal transfers. All transfer prices are negotiated. Required: 1. Refer to case 1 shown above. Alpha Division can avoid $3 per unit in commissions on any sales to Beta Division a. What is the lowest acceptable transfer price from the perspective of the Alpha Division? b. What is the highest acceptable transfer price from the perspective of the Beta Division? c. What is the range of acceptable transfer prices (if any) between the two divisions? Will the managers probably agree to a transfer? 2. Refer to case 2 shown above. A study indicates that Alpha Division can avoid $3 per unit in shipping costs on any sales to Beta Division. a. What is the lowest acceptable transfer price from the perspective of the Alpha Division? h What is the hinhost arrontahle transfer nrire from the norenertive nf the Rota ivicinn?

Answer 1

Case 1:

Alpha division is operating at its full capacity and the entire production can be sold to outside customers.

a. If Alpha division were to sell units to Beta division, transfer price shall be Variable Cost + Opportunity Cost (Contribution p.u ) i.e (68-3)+(104-68) = $101 (after considering savings in commission) which is the lowest acceptable transfer price from Alpha's perspective.

b. The highest acceptable transfer price from Beta's perspective would be its current purchase price i.e., $97

c. There is no range of acceptable transfer prices between 2 divisions and the managers wouldn't agree to a transfer price because accepting either of the transfer prices wouldn't be profitable for the group as a whole. If Alpha agrees to transfer at $97, it loses $4 that it would otherwise have gotten from Outside customers and so does the group as a whole. If beta accepts $101, it would be not gainful for the division as well as firm to purchase a product at $101 while its available at a market price of $97.

Case 2:

Alpha division is operating at its full capacity and the entire production can be sold to outside customers.

a. If Alpha division were to sell units to Beta division, transfer price shall be $42-$3 = $39(after considering savings in shipping costs) which is the lowest acceptable transfer price from Alpha's perspective.

b. The highest acceptable transfer price from Beta's perspective would be its current purchase price paid to outside supplier i.e., $41

c. Range of acceptable transfer prices between 2 divisions = $39 - $41

The managers could agree to a transfer price in the range given above which, if agreed, would be profitable for the group as a whole. However, it would be better if the Alpha offers a transfer price less than $ 41, the price at the which beta would be indifferent.

d. Loss in potential profits of the company as a whole when beta continues to purchase from outside suppliers @ $41 = (41-40)*72000 = $72,000.

Case 3:

Alpha division is not operating at its full capacity and has an idle capacity of 26000 units while Beta needs 23000 units.

Discounted purchase price for Beta = 61 * 94% = $57.34

a. If Alpha division were to sell units to Beta division, transfer price shall be its Variable cost = $38 which is the lowest acceptable transfer price from Alpha's perspective.

b. The highest acceptable transfer price from Beta's perspective would be its current purchase price paid to outside supplier i.e., $57.34

c. Range = $38 - $57.34. Its highly probable that managers could agree to a transfer price as they should since purchasing from outside while having idle capacity in Alpha division would prove costly to the company as a whole.

d. Utilising idle capacity and selling at $52.34 would increase the division's profit by $329,820, therefore, it is expected for return on investment of the division to increase.

Units	75000	23000	Total
SP	$                    61	$                52.34
VC	$                    38	$                38
Contribution	$                    23	$                14.34
Total Contribution	$       1,725,000	$      329,820	$       2,054,820
Fixed costs(75000*$17)			$       1,275,000
Profit			$          779,820

Case 4:

Alpha division is operating at its full capacity and the entire production can be sold to outside customers.

If Alpha division were to sell specially made units to Beta division, transfer price shall be VC + Opportunity cost(foregone contribution of 29000 units) i.e $29+ $13*29000/58000= $35.50 which is the lowest acceptable transfer price from Alpha's perspective.

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